If federal regulators have their way, the mortgage of tomorrow may look a lot like the mortgages of yesteryear, back when an old adage held that, “The only people who can get a loan are people who don’t need one.”
This week, the Federal Reserve and other banking regulators published a much-anticipated proposal for new regulations on banks and mortgages. The most controversial rule, and the most important for homebuyers, would require borrowers to make downpayments of at least 20% to qualify for a loan.
Low downpayments, in many cases as low as $0, “contributed significantly to the high levels of delinquencies and foreclosures since 2007,” according to the proposal.
Nonsense, consumer and homeowner advocates say. Even during the height of the mortgage crisis, mortgages with low downpayments had the same foreclosure rates as loans with higher downpayments, according to research by the Center for Responsible Lending.
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“This is very concerning,” says Kathleen Day, the center’s spokeswoman. “It could really hurt low- and moderate-income homebuyers, who had little to do with causing the problem.”
Banks would still be able to give loans with lower than 20% downpayments. But under the proposed rule, loans with lower downpayments and other features regulators view as risky would not win status as “qualifying residential mortgages,” which means they would not qualify for loans or insurance from Fannie Mae, Freddie Mac or the Federal Housing Administration.
The regulations would require banks to keep more non-qualifying loans on their books. During the housing bubble, banks made billions of dollars’ worth of risky loans. One practice, dubbed “liar loans,” encouraged borrowers to state their incomes on the loan application, with no requirements that they provide paycheck stubs or any other paperwork to substantiate how much money they made.
Banks were happy to give out these loans, even though they were at a higher risk of default, because they derived fees from making the sale. Next they sold most of the loans they wrote to third-party investors, often within days of the mortgage being signed. So when a high percentage of liar loans and other types of mortgages failed, it left investors and American taxpayers—not the banks—holding the bag.
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By requiring banks to keep at least 5% of their riskier loans on their own books instead of reselling them, known as keeping “skin in the game,” regulators hope the banks will see it in their best interest to write fewer risky loans, and to ensure that the fewer high-risk loans they do write end up in foreclosure.
“When securitizers retain a material amount of risk, they have ‘skin in the game,’ aligning their economic interest with those of investors in asset-backed securities,” according to the regulators’ proposal.
Loan servicers—the companies that handle the day-to-day details of administering loans on behalf of investors—would be required to do a better job modifying mortgages when the borrower falls behind.
The proposal also would make it easier to modify a loan by easing restrictions on second mortgages. Currently, lenders or investors who control the second mortgage often kill modification attempts if it means they will receive less income from the new, rewritten mortgage.
Image: Eugene Peretz, via Flickr.com